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Investing Specialists

After Productivity Spike, Expect More 3Q Pleasant Surprises

The spike in productivity is a good indicator that the end of the recession is at hand.

The highly important productivity figures released Tuesday showed an annualized increase of 6.4% for the June quarter, better than most expectations of a gain in the mid-5% range. Compared with the first quarters coming out of past recessions, the gain was pretty typical: The average post-recession gain is just over 6%. However, unlike most past recessions, productivity did not fall meaningfully during the recession itself, as employers cut jobs quickly. So normally, I would have expected a more muted productivity gain coming out the other side of this recession.

The spike in productivity is a good indicator that the end of the recession is at hand. Most big spikes I have seen in productivity have occurred in the quarter when economic activity bottoms, which is consistent with my thesis that the recession ended in the June quarter. The high productivity results are good news for the Fed, too. Higher productivity means lower pressure on prices, which gives the Fed more room to maneuver with its interest-rate policies. From an employment viewpoint, higher productivity means that employers were pressing their employees extra hard, and as activity begins to pick up, employers may be forced to hire workers faster than past recessions. This could be where the surprise comes to most economic forecasts, too.

Corporate profits are also strongly affected by productivity gains. Increased labor productivity was a key factor in explaining why more than 70% of major corporations reported positive earnings surprises in the June quarter earnings. However, sales were down and provided far less upside surprises. If a sales gain is coupled with costs only a little above second-quarter levels, the third quarter could provide another upside surprise.